Institutional Shareholder Services Inc. (“ISS”) and Glass Lewis & Co., LLC (“Glass Lewis”) recently updated their proxy voting guidelines for the 2013 proxy season.  The complete 2013 Updates to ISS’s U.S. Corporate Governance Policy are available here.  Key updates from both proxy advisors relating to executive compensation and compensation-related matters are discussed below.  While the 2013 policy updates represent incremental rather than wholesale changes to the respective advisor’s voting guidelines, they also reflect, at least in part, responses to critiques of their pay-for-performance analyses voiced during the 2012 proxy season.  Public companies are urged to take the 2013 policy updates into account when reviewing existing practices and policies and considering changes. 


Pay-for-Performance: Peer Groups

ISS has not historically taken into consideration a company’s self-selected peer group when comparing a company’s executive compensation and total shareholder return against similarly situated companies.  Instead, ISS has historically created its own peer group based on industry profile, size (based on revenues or assets) and market capitalization.  This methodology was criticized by some companies during the 2012 proxy season for being imprecise and leading to peer groups that were not always fully representative of the subject company’s peers.  The issue was highlighted in a May 2012 Wall Street Journal article by Emily Chasan.  The article set forth as an example ISS’s 2012 peer group for Marriott Corp., which included AutoNation, Penske Automotive Group, Icahn Enterprises and Genuine Parts Co., but did not include Starwood Hotels or Hyatt Hotels, publicly held competitors of Marriott’s.

At least partially in response to this criticism, ISS stated in its 2013 policy update that its peer group identification methodology will now include a company’s self-selected pay benchmarking peer group as an input, in addition to the other factors described above.  This 2013 ISS policy update is consistent with the methodology used by Glass Lewis, which earlier in 2012 revised its peer group identification methodology to incorporate peers identified by the subject company.

Pay-for-Performance: Realizable Pay

The SEC requires companies to disclose in the Summary Compensation Table the value of stock awards made to executives and directors based on the fair value of such awards at the grant date.  A number of companies in recent years have expressed the view that reporting the grant date fair value, or total award opportunity, can sometimes lead to an overstatement of compensation, especially during periods of flat or declining stock performance.  In light of this concern, some companies have added supplemental disclosures of stock award values calculated on an “earned” or “realized” basis.

When ISS evaluates a company’s pay-for-performance, it begins with a quantitative analysis of the information presented in the Summary Compensation Table.  When this initial analysis demonstrates significant unsatisfactory long-term pay-for-performance alignment or misaligned pay and performance are otherwise suggested, ISS conducts a subsequent qualitative analysis of several factors underlying the company’s executive compensation program.

During the 2012 proxy season, a number of companies complained that the traditional pay-for-performance comparison, using grant date pay as reported in the Summary Compensation Table, can sometimes have the effect of overstating pay.  Partially in response to these concerns, ISS has indicated in its 2013 policy updates that, for large cap companies only, it may incorporate “realizable pay” as a factor in its qualitative evaluation of pay-for-performance alignment.  ISS states that it intends to compare “realizable pay” to the grant date pay reported in the Summary Compensation Table as part of its qualitative evaluation and that this comparison may mitigate or exacerbate its pay-for-performance concerns about a CEO.

For purposes of this analysis, ISS defines “realizable pay” as “the sum of relevant cash and equity-based grants and awards made during a specified performance period being measured, based on equity award values for actual earned awards, or target values for ongoing awards, calculated using the stock price at the end of the performance measurement period.”

So far, Glass Lewis has not incorporated realizable pay into its pay-for-performance analysis.  It remains to be seen whether realizable pay will become more widely adopted by compensation committees, and whether Glass Lewis will update its analysis to incorporate this alternative pay definition. 

Hedging and Significant Pledging

Proxy advisors, investors and regulators have emphasized over the past several years the need to align compensation opportunities for executives and directors with the interests of a company’s shareholders.  In light of this emphasis, arrangements that break this alignment have come under significant scrutiny—for example an executive or director hedging against a decline in a company’s stock price, or pledging company stock as collateral for a loan.  To this end, the Dodd-Frank Act requires the SEC to enact rules requiring additional disclosure about whether directors and employees are permitted to hedge any decrease in market value of the company’s stock.  (These rules have not yet been issued.)

Consistent with this trend, ISS’s 2013 policy updates include hedging and significant pledging of company shares by directors and/or executive officers as examples of failures of a company’s risk oversight.  Under ISS’s proxy voting guidelines, material failures of risk oversight can, in extraordinary circumstances, result in a recommendation to vote against or withhold from directors individually, committee members, or the entire board.  ISS believes that hedging of company stock severs the ultimate alignment of company leadership’s interests with shareholders’ interests.  As a result, ISS states that it will consider any amount of hedging a problematic practice warranting a negative vote recommendation.

With regard to pledging of company shares by insiders, ISS has stated that it will consider, among other relevant factors, the following:

  • Whether the company includes in its proxy statement an anti-pledging policy preventing future pledging activity;
  • The magnitude of aggregate pledged shares in terms of total common shares outstanding, market value or trading volume;
  • Disclosure about progress or lack thereof in reducing the magnitude of pledged shares over time; and
  • Disclosure in the proxy statement that shares subject to stock ownership and holding requirements do not include pledged company stock.

The new ISS policy on hedging and significant pledging is an important development.  While many companies already prohibit hedging of company stock by insiders, those that do not may wish to implement anti-hedging policies now to avoid a negative ISS recommendation.

At the same time, pledging arrangements continue to exist at some companies.  Companies may wish to take steps to restrict these arrangements going forward, but wholesale prohibition might be difficult because pledging arrangements can take a variety of forms, and terminating existing arrangements can create logistical and financial burdens.  The ISS policy suggests that some pledging may be reasonable and appropriate.  We hope that ISS will provide further guidance on where lines should be drawn.

Glass Lewis

The Glass Lewis U.S. policy updates for the 2013 proxy season were relatively minor—particularly with regard to executive compensation matters.  Of note is that Glass Lewis, which bases its evaluation of equity-based compensation plans in part on a list of “overarching principles,” has added a new principle, regarding dilution, to its process for evaluating proposals regarding equity-based compensation plans.  Specifically, Glass Lewis has stated that plans should not count shares in ways that understate the potential dilution, or cost, to common shareholders.


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Photo of David H. Engvall David H. Engvall

David Engvall provides securities, transactional and general corporate advice to clients ranging from development stage ventures to large public companies.  His work includes private and public equity and debt securities offerings, investment transactions, corporate governance matters, and mergers and acquisitions.  Mr. Engvall also…

David Engvall provides securities, transactional and general corporate advice to clients ranging from development stage ventures to large public companies.  His work includes private and public equity and debt securities offerings, investment transactions, corporate governance matters, and mergers and acquisitions.  Mr. Engvall also advises public company clients on a wide variety of SEC compliance and disclosure matters.  Recently, Mr. Engvall has been actively engaged in advising clients on a number of securities law provisions under the Dodd-Frank Wall Street Reform and Consumer Protection Act, including executive compensation, corporate governance, and specialized disclosures such as those pertaining to conflict minerals.  His practice includes clients in a variety of industries, with a recent focus on the energy, financial institutions and telecommunications industries.